Employee Cell Phones Generally Are Now Nontaxable

By Drew Cheney October 23, 2011

In September 2011, the Internal Revenue Service (IRS) issued Notice 2011-72, which provides helpful and long-awaited guidance on the taxation of cell phones and similar telecommunications equipment (hereinafter referred to collectively as “cell phones”).  In addition, the IRS issued a related memorandum to its field examination agents that provides additional clarification regarding cash allowances and reimbursements for work-related personal cell phones.  Those documents may be found at the following links, and are explained in more detail in this article.

http://www.irs.gov/pub/irs-drop/n-11-72.pdf

http://www.irs.gov/pub/foia/ig/sbse/sbse-04-0911-083.pdf

Background

In 1989, when cell phones were much more expensive and exotic than they are today (you may recall Gordon Gekko’s toaster-sized cell phone in the 1987 movie Wall Street), Internal Revenue Code Section 280F was amended to include cell phones in the category of “listed property.”  This meant, among other things, that for related costs to be deductible (or for a reimbursement to the employee to be tax-free), a taxpayer needed to substantiate the cell phone’s business use.  The rules also imposed certain record-keeping requirements, but the nature and extent of these requirements was the source of much confusion.

The Small Business Jobs Act of 2010 removed cell phones from the definition of listed property, but considerable uncertainty remained regarding (1) the extent to which the personal use of cell phones was taxable and (2) how business use could be demonstrated to the satisfaction of the IRS.  That uncertainty is addressed with the recent addition of Notice 2011-72 and the IRS Memorandum.

Current rules (Notice 2011-72 and the IRS Memorandum)

Notice 2011-72 explains that if an employer provides an employee with a cell phone for reasons primarily relating to the employer’s business, other than providing compensation to the employee (in the form of use of the cell phone), then the value of any personal use of the cell phone is excludible from the employee’s income as a de minimis fringe benefit.  The Notice lists the following examples of substantial noncompensatory business reasons:

• The employer’s need to contact the employee at all times for work-related emergencies;
• The employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office; and
• The employee’s need to speak with clients located in other time zones at times outside of the employee’s normal work day.

The IRS Memorandum applies the principles of Notice 2011-72 to employer reimbursements for the business use of an employee’s cell phone.  If an employer, for substantial business reasons (using the criteria discussed above), requires an employee to maintain and use a personal cell phone for business purposes, then reimbursements for the employee’s cell phone costs will not be taxable, provided that:

• The employee maintains a type of cell phone coverage that is reasonably related to the need of the employer’s business, and
• The reimbursement is reasonably calculated so as not to exceed expenses that the employee actually incurred in maintaining the cell phone.

The Memorandum provides the following example of a situation in which the reimbursement is not taxable, even if the cell phone is used for personal purposes:

• An employer requires the employee to maintain a personal cell phone to facilitate communication with the employer’s clients during hours outside of the normal work day;
• The employee’s basic cell phone plan charges a flat rate per month for a certain number of minutes for domestic calls; and
• The employer reimburses 100% of the basic charge.

Conclusion

IRS Notice 2011-72 and the Memorandum provide welcome relief from uncertainty and complexity related to taxation of cell phones.  However, regardless of whether an employer chooses to provide its employees with cell phones or to reimburse the employees’ costs of their own cell phones, employers should be careful to document the substantial business reasons for requiring the employees to have cell phones.